To borrow or not to borrow? That is the question
Now is a great time to grow a business, but should you borrow or raise capital? Our financial expert Robert Jones explores the options with the principal of Business Growth Strategies (BGS) Richard Ireland
The current economic situation means that, if you are not looking at ways to grow then you may be looking at downsizing.
The changing economic environment has created opportunities but only for those companies who have the vision and the funding to go for them.
It is often said that if you have a good business or business idea, and good people, then the only thing holding your firm back is a lack of funding – for product and infrastructure development, marketing and brand awareness, corporate structuring and staff appointments, development and motivation.
So the question for many businesses is how do you finance growth and what is the best option for your firm?
Richard Ireland of Business Growth Strategies (BGS) offers the following advice:
1. Going into debt means paying interest
The major source of debt financing is through a loan, usually through a major bank. Borrowing money of course means that it has to be repaid, at interest, over a certain period of time.
It also means that security, often over personal assets of the business owners will need to be provided.
It is therefore often the case that the capacity of a firm to finance growth is limited to the capacity of the owners to provide security, often in the form of first mortgage finance over the family home. The advantage of debt finance is that once the loan is repaid the owners retain one hundred percent of the business.
This of course is of little comfort if the firm is held back because of lack of capacity to borrow money. An alternative to debt funding is capital or equity raising.
They are however, not mutually exclusive and both debt and equity funding is used by many companies.
2. You may loose control if you bring in a partner
The most common way to raise private capital is to bring in a business partner, perhaps someone already known to the owner or an outside investor, often called an angel investor.
In both cases, the investor is putting money into your business in exchange for a share of the business, both potential profits and a share of the proceeds in the event of sale. The advantage over a loan is that there is no interest, no debt to repay and no security required.
It does however mean that there is now another part-owner who will expect a say in running the business. He/she may also have an exit strategy that may differ from yours. Finding the right person to be a business partner or angel investor is often difficult.
Even if one does find the cherished angel investor many business owners seek, terminating the arrangement if it doesn’t work out can be even more difficult.
Finding a business partner or angel investor really means finding a part-owner for your business with all the restrictions that entails.
3. You can raise money from shareholders without being listed on the stock exchange.
A somewhat different approach is to raise capital from a number of passive shareholders – investors who invest money with the expectation of future profit by way of dividends and growth in the share price of their shareholding. They have no involvement in the strategy or day to day running of the business. If they become dissatisfied with your company’s performance they can sell their share.
Generally speaking the Corporations Act 2001 prohibits small businesses approaching the public for capital without a prospectus which can be very expensive to prepare.
The law however, does provide a limited opportunity for small businesses to raise capital without an expensive prospectus. Under one exception, small businesses may raise capital under what is called the 20/12 Rule.
Under these provisions small business owners can raise up $2 million from up to 20 “retail” investors in a 12 month period. There are restrictions on advertising and the offers must be personal offers.
Certain classes of investors such as existing owners, people resident overseas and what is called “sophisticated Investors” do not have to be counted so one could finish up with a lot more than 20 investors without breaching the fundraising provisions of the Act.
4. You don’t need a prospectus to raise capital
Capital may also be raised through an Offer Information Statement (OIS).
This Disclosure document is still not a prospectus but requires a higher level of disclosure than under the 20 /12 Rule.
The document must be registered with ASIC. Funds raised can be up to $10 million (less capital previously raised) and restrictions on advertising do not apply. A small business may elect to raise initial capital under the 20/12 rule and then look to raising additional capital under an OIS. One reason for this approach is so that listing requirements to a stock exchange can be satisfied before seeking an IPO.
Raising capital from a number of passive investors (as opposed to active investors such as business partners or investor angels) requires an “investor friendly” environment if you are to attract investors.
As a private company, the law requires only one director, it does not have to produce audited accounts and the major shareholder can refuse to transfer the shares, without giving a reason. This is hardly a satisfactory environment for a passive shareholder. For this reason it is often advisable to set up or convert the existing private company to an unlisted public company.
5. You must decide how your business will be managed
Having established the right vehicle it is also necessary to structure the initial share offer to attract investors.
A further consideration is the composition of the board. Having outside shareholders places additional responsibilities on the business owners.
Often these skills may need to be acquired by boosting the board with experienced people who have previous board experience. This will be an additional comfort to shareholders.
Further, as offers under the 20/12 Rule are personal offers, having directors (a minimum of three) with experience and their own network of contacts will assist greatly in attracting early stage investors.
6. Consider listing on an exchange
Up until now we have been discussing raising capital through an unlisted company. Listing on a stock exchange requires the issue of a prospectus and a whole new compliance regime. The most well known exchange is the Australian Securities Exchange (ASX).
It of course has the biggest market place but you probably need to be capitalized at around $50 million to attract broker interest and cover the listing and compliance costs.
The National Stock Exchange (NSX) is a stock exchange for SME’s, and is often regarded as a precursor to an ASX listing.
The NSX has lower listing requirements and is certainly cheaper. In both cases shares must be traded through a broker and in the case of the NSX you will also need a Nominated Advisor to guide you through the process.
Listing on a stock exchange generally means that your business will trade at a higher multiple than a private company.
Raising capital to fund growth offers considerably more scope that relying on debt alone. Capital or equity involves issuing securities in your own enterprise – a form of currency if you like.
This article has indicated a number of steps that can be taken, from raising initial capital through to a stock exchange listing, initially on the NSX.
A stepped approach allows a company to grow in a positive, practical manner and is not too hard if you know the process.
*BGS specializes in growth strategies for small and medium size businesses. BGS deal with high growth companies who are interested in taking their business or business idea to the next level. They operate a Business Matching Service to assist companies raise initial capital. BGS is a Nominated Advisor to the National Stock Exchange.
Business Growth Strategies
Ph: 1300 134 331
Ph: 0438 832 491